Balance key in growth v austerity debate

International investors are watching with a growing sense of unease as members of the “growth" club in the economics profession take on their “austerity" adversaries.

For most people in the markets, it’s an artificial dichotomy. Investors know that the heavy debt levels that Western countries have accumulated means that political leaders simply can’t ignore the problems of deficits and debts. But they also realise that cutting government spending and raising taxes inevitably leads to slower growth, which in turn reduces government revenues and makes the debt burden even more oppressive. At the same time there’s a risk that stimulus measures will produce only fleeting increases in economic activity and then leave governments nursing even larger debt burdens.

For investors, the issue isn’t whether the “growth" camp, or the “austerity" camp wins the current debate, it’s whether the major Western countries can work out a way to reduce debt levels without suffocating economic activity. It’s an extremely difficult and precarious balance to achieve, but unless such a balance can soon be found the global economy is at risk of sliding into a deep recession.

Already, the US economy is feeble and although most investors believe some sort of deal will be reached on the country’s “fiscal cliff", it will do little to resolve the large US budget deficit, which is now close to 10 per cent of gross domestic product. The Chinese economic slowdown is deeper than expected, with figures out this week expected to show the economy only expanded at 7.4 per cent last quarter, the slowest in three years.

Meanwhile, debt-laden eurozone countries are still grappling with the massive task of cutting their budget deficits at a time when their economies are slumping deeper into recession. And European politicians have done little to address the problems of the precariously overleveraged European banking system.

Meanwhile, it is clear that money-printing by central banks is reaching its limits. The decision by the US central bank to continue buying $US40 billion of mortgage-backed securities until the US jobs market improves has left investors with very little to anticipate in the way of additional easing. And Spain’s continuing reluctance to seek a bail-out has highlighted the limitations of the European Central Bank’s pledge to buy “unlimited" quantities of bonds to reduce the borrowing costs of troubled eurozone countries. The problem is that emerging economies are now showing less enthusiasm for the idea that they should implement growth policies in an effort to boost the global economy. While South Korea and Brazil announced interest rate cuts last week, Singapore, India and China have resisted cutting rates for fear of sparking inflation.

At the recent meeting of global financial chiefs in Tokyo, South Korea’s central bank chief Kim Choongsoo argued there was ‘‘ample room for promoting domestic demand-driven growth, especially in Asia", adding that “further fiscal and monetary stimulus should help boost domestic demand and ultimately the world recovery".

But the idea was shot down by Russian Finance Minister Anton Siluanov, who argued that it was more important for emerging nations such as Russia to boost their appeal for investors by narrowing their budget deficits.

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He added that those countries urging the emerging countries to come to the rescue of the world economy “should really move faster to implement their own structural reforms back home, including reducing state debt".